3 Reasons To Buy Costco On The Pullback

Summary

Costco is rapidly expanding into more markets and this will enable it to tap a bigger share of the warehouse retail industry.

Costco is focused on improving merchandise and sustain membership growth, which will allow it to improve its financial performance.

Costco's technology moves will allow the retailer to benefit from the growing adoption of e-commerce.

Warehouse retailer Costco (NASDAQ:COST) is underperforming the market this year. The stock has dropped around 1% so far. However, Costco plies its trade in the huge warehouse retail industry. According to a report, the warehouse retail industry is worth $148 billion, and Costco is making a number of moves to tap this growth. As a result, it won't be surprising if Costco comes out of its slump going forward.

Expansion will drive more customers

Costco is rapidly opening stores across the globe to gain more customers. It recently opened four new locations in the third quarter: two in the U.S., one in Louisiana and one in Texas; and one each in Japan and Korea; after opening 60 new locations during the first half of fiscal 2014.

Costco also opened its first store in Spain, in Seville, bringing its 2014 fiscal year store openings through the third quarter end to 20. In addition, it plans to open its sixth location in Australia in Brisbane, its 11th Korean location, and its 20th Costco in Japan, making it three openings outside of the U.S. in a short time.

Costco plans to open six more locations, four in the U.S. and one each in Canada and the U.K., and end the year with 30 new openings. Management estimates that the retailer will have 663 worldwide stores by August 31. These aggressive store expansion moves by Costco will allow it to sustain the terrific growth rate that the company has seen in recent times. For example, Costco's sales in the third quarter came in at $25.2 billion, a 7% increase from $23.5 billion in the year-ago period.

Improving merchandise and memberships

Apart from store expansion, Costco has also focused on improving its merchandise. Its merchandise categories posted strong growth, with food and sundries standing out with mid-single digit growth. Small electrics, domestics, and apparel categories are also delivering solid growth, recording mid to high single-digit comps in the previous quarter. In addition, sales of fresh foods are also tracking higher. They were up 8% last quarter, with produce and meat being strongest.

Another important factor driving Costco's results is its memberships. Costco is enjoying robust renewal rates in terms of membership. For instance, last quarter, its renewal rate was 90.6% for the U.S. and Canada, and 87.3% worldwide. In all, the new member signups increased 1% during the third quarter, driven by some of the Asia opening schedules where new member signups grew.

Technology moves

Moreover, Costco is focused on re-platforming and adding mobile apps to enhance sales. It is combining some of the e-commerce merchandising buying efforts with its line efforts. Hence, it has added a few categories like apparel, a few limited apparel items, and some limited health and beauty items to its portfolio.

Costco also delivers a solid value proposition to customers, who can save a lot of money by buying products from its warehouses. As reported by Trefis:

"A warehouse retailer charges an annual membership fee to its customers and provides a wide variety of merchandise at discounted prices. The U.S. warehouse club industry comprises of three main players - Costco, Wal-Mart's Sam's Club and BJ's Wholesale Club - with Costco being the strongest of the lot. Some consumer reports suggest that buyers can save up to 55% while shopping at warehouse clubs. Due to these bargains, the warehouse club industry sales have grown at a higher rate than general merchandise store sales over the last decade. Costco's annual comparable store sales growth has averaged around 6% for the past three years, thanks to new membership signups. We do not expect any significant slowdown in the industry growth in the future as pricing benefit is something that buyers will always welcome as long as they are offered good quality products."

Additionally, the company is rapidly expanding its Costco Online concept. It recently announced that it will expand in four countries - the U.S., Canada, the U.K. and Mexico. Expansion into the online space is important for Costco, as the e-commerce space is growing at a fast pace. Trefis goes on to report:

"The online retail market in the U.S. has grown rapidly since 2004 and the long term outlook remains optimistic. Forrester forecasts that online sales in the U.S. will grow 13% to $262 billion in 2013 and reach $370 billion by 2017. This presents a huge growth opportunity for Costco's online sales, and it has been going with the trend. The retailer's e-commerce revenues increased by 20% and 15% in Q3 and Q4 respectively, backed by its e-commerce strategy, website re-platforming and mobile apps. Costco's main strategy for its online business is to offer distinct products on the e-commerce site to keep its customers interested. About 80%-90% of its products offered online do not overlap with the stores inventory, which enables to retailer to prevent some cannibalization of its store sales. Moreover, online sales account for just 2% of Costco's net sales indicating that there is a huge room for growth."

Conclusion

All in all, Costco is on track to deliver solid growth in the long run. Additionally, the company's valuation is also enticing. According to Yahoo Finance, Costco has a trailing P/E of 26, and the forward P/E of 23 indicates earnings growth. Finally, the company's earnings are expected to grow at a robust CAGR of 10.22% for the next five years, making it a good long-term pick.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.